Roundy's Could Turn Around Soon

| About: Roundy's Supermarkets, (RNDY)


Buying stocks trading at 52 week lows is difficult while markets are near all time highs, since there are not many and you can temporarily look quite foolish.

However, these shunned stocks could be where the value is in this overstretched market, if they have a strong enough business to turn things around in a still improving economy.

This article will look at a stock currently trading near a 52 week low that offers potential upside due to a solid turnaround plan that is being underestimated.

Roundy's is a company that is transitioning to focus on their premium Mariano's brand, but struggling legacy grocery stores and a high debt load are holding them down.

The CFO's just announced departure is not a worrisome sign, because he is still a major shareholder and recently joined other insiders in purchasing shares.

It can be extremely painful to own stocks trading at 52 week lows while the broader market continues to roar to all time highs, much less bring yourself to buy more while they're languishing down at these levels. However, if you believe in a company's recovery it can be an opportunity to add to your holdings at an attractive price while they're beaten down.

Using these bottom fishing techniques exclusively can sometimes get you in trouble if you buy into businesses that are truly broken. After all, as hedge fund manager Leon Cooperman succinctly said last week at CNBC's "Delivering Alpha" Conference, "If every stock you own is on the new high list, you're a momentum guy. If every stock you own is on the new low list, you're out of business."

However, contrarian buys can pay off if the company's business is not permanently broken, and solely the market's current bearish perception of the stock is driving it down. In this article I try to identify a stock trading as though their business is irrevocably broken, but which I believe can transition quickly enough to provide compelling long term value.

Roundy's (NYSE:RNDY) is the owner of several chains of grocery stores in the Midwest, including Pick 'n Save and Copps in Wisconsin, and most importantly, Mariano's in Illinois. Mariano's is the namesake of Roundy's Chairman and CEO Bob Mariano, and is clearly where the company is placing their bet for the future. The stores are more upscale and health focused, offering a Whole Foods like experience including amenities like sushi and grilling stations.

The Mariano's concept has been a resounding success, with each store averaging about a million dollars in weekly revenue according to a recent investor presentation. This is more than double what the rest of their stores are bringing in on average, but this could be considered good or bad since the Mariano's banner currently only makes up about 15% of their total stores, although it should account for over 30% of their total sales by next year.

Part of this change in revenue mix is the aggressive expansion of Mariano's, which will add 11 more stores by converting the Dominick's locations they bought from Safeway (NYSE:SWY), and has also signed leases or letters of intent for at least 14 additional locations. But the shift is also due to the widening performance gap between Mariano's and their other older brands, with the former already showing same store sales growth in the high single digits at stores that have been open for more than a year, while comps at the latter legacy locations were a dismal negative 5.2%.

Having these declining same store sales at the majority of their stores while building out the Mariano's banner has continued to weigh on earnings, as the company only earned a measly penny last quarter. Earnings per share is expected to decline to 20 cents this year, down from over 80 cents in 2013. It is expected to earn almost 40 cents next year, but this is certainly in flux given the difficult last quarter, thus estimates are wide ranging between 16 and 50 cents amongst analysts.

However, while earnings can be volatile, the supermarket business is an underrated steady generator of cash flow. This is one of the reasons that chains like Albertson's and now Safeway are often targets of private equity buyouts by hedge funds like Ceberus Capital. Ceberus originally bought Albertson's from SuperValu (NYSE:SVU), which coincidentally is also a top pick of Cooperman as they sell off assets and restructure the rest of the business.

The reason I mention this is that Roundy's is attempting a similar strategy, using the cash flow from their legacy brands to grow out the Mariano's banner in the Chicago metro area. It has also joined the supermarket shuffle in selling its Minnesota based brand Rainbow to SuperValu for $65 million in cash plus the proceeds from inventory sold as the stores transition to the new owners, and the deal is expected to close soon.

This will supplement the Mariano's buildout, and shareholders should be happy to swap the tired old non-core brand for the nicer, newer Mariano's locations, as the cash received should go a long way towards the $36 million purchase price of the 11 Dominick's stores plus the planned $45 million cost of eventually renovating all of them into Mariano's locations.

There are also 9 remaining Rainbow locations that have not been sold yet, but which are expected to be sold or closed in the third or fourth quarter. This could bring in some additional cash, or at the very least save some money as the company trims its operations and infrastructure to reflect their exit from the Twin Cities market.

Once the Rainbow stores have been excluded, the company's same-store sales guidance for the second quarter is expected to be in the range of negative 2% to negative 1%. While better than the previous quarter, this is still not good and seems to be a bit cautious given that some of the first quarter slowdown was due to lousy weather and the Easter holiday calendar shift.

The CEO went out of his way in the Q&A portion of the conference call to say they had not seen an acceleration in comps coming out of the tough first quarter, suggesting they are being very conservative to avoid another disappointment. Any improvement in the rest of their stores, coupled with contributions from the better performing Mariano's brand could lead to an upside surprise.

Still, investors apparently don't think the Mariano's initiative will gain critical mass in time to stop implosion from their struggling existing store base and high debt load, with a debt to equity ratio of about 3. However, I think the company will continue to be able to tap into either the cash flow from existing stores, not to mention the better performing Mariano's as they come on line and start to represent a larger portion of their business, or perhaps continue to or monetize non-core assets like they did with Rainbow. On the last conference call, CFO Darren Karst said the following:

"As of March 29, 2014, we had $32 million of cash and cash equivalents and $142 million of availability under our asset base revolving credit facility, providing us with liquidity to operate our business."

Also shortly after the last earnings report, several insiders purchased shares. While not exactly huge purchases, it hardly seems like they'd be putting anything into the company if bankruptcy were imminent, and it's worth noting that large insider purchases also marked the all time low of the stock back in November of 2012. CFO Karst purchased shares both times, which is notable because yesterday after the closing bell it was announced that he was leaving to take the same job with Rite Aid (NYSE:RAD).

Given that he still owns over half a million shares, I hardly think it's likely that he's leaving because he thinks the company is a sinking ship, so I think investors would be wise to follow his lead and own shares in the company. If the market overreacts to the news of his departure tomorrow, I think it would be an excellent time to get into the stock just as the Mariano's concept proves it can continue to expand and become a larger component of a successful Roundy's turnaround.

Disclosure: The author is long RNDY, SWY. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.